"A Strategic Economic Engagement" With China on Trade and the Environment

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GIDEON ROSE: Welcome, everybody. This is Gideon Rose, the managing editor of Foreign Affairs. We're extremely fortunate to have with us Secretary of the Treasury Henry Paulson, who will talk with us about his article in the new issue of Foreign Affairs on U.S.-China relations.

Secretary Paulson is an extremely distinguished figure with a long resume. He obviously was chairman and chief executive of Goldman Sachs before this. He's been Treasury secretary for more than two years now. And we are very delighted to have him with us.

Secretary, let's get right to it. What -- for those few who might not have read your article as carefully as they should have --

SECRETARY HENRY PAULSON: Heaven forbid~! Yeah. (Chuckles.)

ROSE: -- (chuckles) -- can you start with a short little precis of what exactly the gist of the piece was?

PAULSON: Yes, Gideon. The -- what we did was summarized our experience with the Strategic Economic Dialogue. And I guess in summary I would say that the U.S. bilateral relationship with China is very important and that our interest and China's intersect on every important issue facing the world today, virtually. You have economic, national security, energy, the environment, foreign policy. And neither of us will accomplish all we want unless we are willing to work with each other. And really on just about every major economic, political, security issue, the path that China chooses will affect the United States' ability to achieve its goals.

So we believe very much in engagement and that building on areas of shared interest and making progress on shared goals builds the foundation that makes it easier to resolve differences. So that is a pretty straightforward thesis.

And then I think the other thing you need to know about China is that China needs robust and sustained economic growth. It's a social imperative. And so Beijing views its international interactions primarily through that economic lens. And so approaching China through economic issues of interest to both countries is an effective way to get tangible results in both the economic and the non-economic areas.

So the -- now, a bit about -- I'll just make one other general point, and then I will move to a few points about the Strategic Economic Dialogue. I think there are some people that look at China's economic success as a threat that somehow we need to counter or contain and somehow their success is going to hurt the U.S. And I think these people are worried about the wrong thing and that frankly China's continued economic growth is important to global economic growth and is a positive for the United States.

The real concern should be that China stumbles, has problems along the way, and that this hurts the -- you know, the global markets, the global economy. It hurts our economy. And a big part of, I think, our engagement with China is about encouraging them to continue with their economic reforms, continue with opening up their economy, working to convince them that the risks are greater in moving too slow as opposed to moving to quickly, because stability is very, very important to China.

Now, what we've done with the Strategic Economic Dialogue is recognize that decision-making in China is diffuse and that the right way to make a difference is to get to a broad array of senior ministers.

And so although we have regular access to the top, to Hu Jintao and Wen Jiabao, and I have frequent access to my counterpart, first Wu Yi and then Wang Qishan, that we also when we get together twice a year and, you know, then in all the discussions in between, we get together with a broad array, 12-15 of their ministers.

And so when we make the case for currency, it's not just Zhou Xiaochaun, the central bank head, that hears it, when Ben Bernanke makes that case, because he's not the decision-maker. There's a good number of other people who are getting educated on this issue.

Or when we're talking about why we shouldn't have tariffs, on environmental goods or services, or talking about the 10-year framework, on energy and the environment, we're talking not just with the environmental minister or the head of the NDRC, Zhang Ping; we're again talking with the finance minister or Chen Deming, the head of MOFCOM, or whatever.

So that's the format. And we've found that from the U.S. government's perspective, there were 50 some-odd economic dialogues, before we seek this. And this helps us prioritize, helps us get the maximum leverage. And so it helps us, in terms of our internal communication and prioritization, I think. It helps the Chinese.

And then in conclusion, I would say that the -- one other point -- the objective here is to talk about not just long-term strategic issues, where we very much engage, but to also deal with the most pressing issue at any period in time.

So for instance, when we began this, it was currency. Currency continues to be an important issue; currency and IPR. But we wouldn't have guessed that, at that time, that product safety and the whole integrity of imports and trade was going to become as important an issue as it was. And we are able to, I think, address this very effectively through the SED.

When there are times of tension, the fact that we have regular communications and have a bond of trust allows us to manage through the tension. I get on the phone, talk with my counterpart. We have various ministers that know their counterparts -- you know, Chinese, know their Cabinet counterparts in the U.S. So when we have the countervailing duties or the WTO cases filed on IPR, we're able to talk it through with the Chinese.

And so as a result of this, we've made the point to them all the way along that as we're working on important strategic issues that are longer-term in nature, we need signposts or tangible results along the way. And so we've been able to, I think at every one of our SED sessions, have lists of things that have been achieved that otherwise wouldn't have been achieved, which are tangible results that we're making progress.

And then, of course, we're dealing with some very significant issues. When I was in Beijing this last week for the Olympics, I was able to spend time again getting ready for the next SED, and working very hard to have some more real progress on this 10-year framework on energy and the environment, where that's -- you know, energy is a very, very significant issue in both of our countries right now.

We've been talking to them for some time about how counterproductive it is to have subsidies, for instance, for oil, and began talking about it some time ago. And I was gratified that, you know, while Wang Qishan was still in the country after the last SED, they announced the reduction in their subsidy in the oil area. But there's a fair number of things that we're working with them on right now, the biggest emphasis being the 10-year framework and the bilateral investment treaty.

I think one of the beauties of the 10-year framework on energy and the environment is that we've got very much of a shared interest in the energy area. We're both very large importers of oil. We share the same energy security issues. We both are hurt by disruptions. We both benefit if there's more efficiency. There are a number of ways we can collaborate. And of course, on the environmental issues we can't solve climate, the climate issues. We can't solve that issue without cooperation and engagement with China and the development of new technologies and the deployment of new technologies.

So again, there's a lot for us to work on. We're making progress. But I'll end where I began, by saying if we get the economic issue right with China, it's going to benefit both of our countries and it's going to be very important in terms of the economic progress, but if we get the economic issue right, it's going to help us get all the other issues right, because that issue is so important to China.

ROSE: Well, that's great. I want to get right to our questions. Let me just take one more comment from my end first.

You have Treasury pursuing this dialogue. You have various other departments in the executive branch with somewhat perhaps different perspectives, whether it's Defense or State and so forth. You have Congress with its own issues and attitudes towards the relationship. How do you as a Cabinet member or as a Treasury secretary, how do you pursue this kind of policy while also getting coordination across the entire U.S. government?

PAULSON: Well, that is a huge challenge, but that's a benefit because the way this was structured is I don't do this in my role as Treasury secretary. That need -- the concept here is you have one Cabinet minister or minister on each side that has overall responsibility for coordination, prioritization and leading the dialogue. And it's important in that each side picks someone that has, you know, has got the trust of the head of state because George Bush and Hu Jintao put this in place and they have, you know, the confidence of the respective presidents and have the ability to coordinate. And I think one of the benefits we've had in the U.S. is it's brought us together closer as a Cabinet. And we've been able to -- you know, we talk through differences, we prioritize and we work together so we can be more effective.

Now, in terms of Congress, I have actively engaged with Congress. I spend a lot of time with leaders of the key committees explaining what we're doing, talking to them about the results. And I believe that it's made a difference because I think you've met -- there was a lot of discussion early on about punitive legislation as it relates to currency. I think that Congress has been satisfied. We're making progress. I've also, when the Chinese come here, I encourage them, both Wu Yi and Wang Qishan, to meet with the leadership of the House and the Senate. So, it's not easy, but that's an advantage of this mechanism because it forces us to coordinate and speak with one voice. And I think when you do so, you've got more leverage and you're more effective.

ROSE: Okay. Well, you know, there are so many who want to get to you that I don't want to stand in their way. So, at this point, given that we're running till noon, let's throw it open to our audience.

OPERATOR: At this time, we will open the floor for questions. If you would like to ask a question, please press the "star" key followed by the "one" key on your touch-tone phone now. Questions will be taken in the order they are received. Once again, that's the "star" key followed by the "one" key to ask a question.

Our first question comes from Pete Kasper with the Thomson Financial News.

QUESTIONER: Can you hear me?

PAULSON: I can.

QUESTIONER: Oh. Okay, good. Thanks. Thanks, Mr. Secretary.

Two quick questions on currency, one to follow up on what you just said. You said you think Congress has been satisfied that there's progress being made on currency. And I'm wondering if you would talk a little bit about what you expect. In other words, would you expect bills to come up next year? Obviously, it's a year when you're gone, but would you expect them to sort of lie low for a while?

A related question would just be -- and I wonder if you could speak about -- aside from the number change, it's been about 21 or (2)2 percent, I think, that the renminbi has increased in value.

PAULSON: Right.

QUESTIONER: But aside from just watching that digit, what changes in the world do you see that have happened directly because of that increase? I mean, would you credit more U.S. exports to China with this currency thing or, you know, what other changes do you see coming from that --

PAULSON: You know, let me -- I thank you for the question, because I think it's an important one. First of all, I -- "satisfied" may have been too strong a word, okay, but there's no doubt that Congress -- because I'm not, you know, entirely satisfied. But I think Congress believes and can see change, because the rate of appreciation has increased.

And when you look at currency -- and as to what might happen next year, I can't speculate, because I -- you know, the IMF is going through their own process, in terms of currency. And we have a -- you know, we are encouraging the IMF to play a greater and a stronger role in currency surveillance.

I would say also I have -- as I go around the world, you know, I've talked with other leaders in other countries about currency. And I think there is a shared understanding that although China is not yet, you know -- China is very unusual, because there are many countries in the world that don't have a market-determined currency, but there's no country as big and as global economically and as integrated into the world markets, in terms of trade in goods and services as China is that doesn't have a market-determined currency. So I think there are few people out there that think they're ready to have a market-determined currency, but everyone would like to see them have a currency that more accurately reflects economic fundamentals. And so what we're talking about is a rate of change.

Now, I don't believe -- you know, your second question is what's been the impact on our exports to China, balance of trade and so on. I want to step back and say I believe that although currency is important in that regard, it is not the biggest driver.

And the reason we have the -- and there's been progress on the trade imbalance with China. But the reason we have this imbalance is because we save at a very low rate; they have precautionary savings at -- you know, at almost 50 percent. There are big structural differences, which is where we're really focused with the SED.

So to me, the biggest reason for having the currency continue to appreciate and reflect market fundamentals is because that's key, as far as I'm concerned, to opening up and reforming the economy and making it a market-driven economy and having it be a balanced economy that is not too dependent on low-cost manufacturing exports and is an economy where there's more consumption and more reform. And I don't think that they are going to be successful if -- as they get bigger and more complex, if they are caught somewhere between using market-driven mechanisms and markets and administrative mechanisms. This will become very difficult. It's difficult for them to control inflation if they can't use monetary policy and if they have a currency that doesn't reflect economic fundamentals. So although I think there's obviously been some impact in the trade numbers, I don't think that currency alone is the big driver here. But I think it is a very important indicator in terms of where they are with their reform, and I don't they're going to get where they need to get or we need them to get unless they keep reforming their currency.

QUESTIONER: Hi. Thank you, Mr. Secretary. I wonder if you could talk a little bit about what the focus of the next SED will be, if there's an overarching theme that you and the Chinese have agreed upon yet. And how much do you think the lame duck nature of the administration will play into Chinese commitments in the next SED?

PAULSON: Well, I -- again, good question, because the -- we have two major issues we're working on, and there's always a variety of other things we're working on all the time.

But we intentionally chose this 10-year framework on energy and the environment because it's long-term, number one; number two, because it is less -- there's less tension around this than there are some of the trade issues; and it's a topic that gets great buy-in and interest from both of our publics. The Chinese care very much about the environment -- (inaudible) -- concerned about it. Here we have a -- (inaudible) -- together. It's something where there's bipartisan interest and buy-in.

So the idea was that if we come up with this framework where we are focused on energy efficiency, energy security, and then we've segmented it also looking at water, looking at air, looking at transportation, looking at conservation -- so we're focused on big areas -- the idea would be that we would come up with enough tangible, concrete progress that people could look at the potential. But yet it is such a big topic and it's one that's going to involve not just the governments but NGOs and the private sector and members of Congress -- so we've worked to get congressional interest and we've got interest from both sides of the aisle -- that this would be something that would -- there would be a lot more to be done, and it's something that would be, I think, important and easy for a new administration to buy in to and to shape as they go forward. So with that in mind, that was one of the reasons why we chose that topic.

The other topic is one that is again very challenging and very important. We are working in an attempt to negotiate a bilateral investment treaty. And here there's a lot of U.S. investment in China, and to get the protections that our investors need is something that's important and difficult to do. And they, on the other hand -- there's very little investment the Chinese have in the U.S., and we think it would be a positive for both of our countries to have them have more investment in the U.S. So again, we've taken that on. That's a very challenging topic.

OPERATOR: Thank you.

Our next question comes from Jim Berger -- or David Sanger with New York Times.

QUESTIONER: Thank you, Secretary Paulson, for doing this. I wanted to follow up on what you've been asked about on the -- (inaudible) -- energy and also on the environment. When the president first rejected the Kyoto Accord in 2001 -- which was not something you were around for. We were several Treasury secretaries before you, I think. At that moment he raised the issue that the accord didn't work without china.

PAULSON: Right.

QUESTIONER: And said that this, in fact, China and India's nonparticipation, was the biggest single flaw. I did not see, until you started up your strategic dialogue, that we had any engagement of a serious nature with the Chinese on the energy issues, until basically a year and a half ago when you began. Do I have the date right on that? I think roughly --

PAULSON: We began -- I started working that right after coming down here, and I think we had the -- we started talking with them late in the summer, and then we had the first SED meeting in December, but I was there in September to set it up.

QUESTIONER: December of '07?

PAULSON: Yeah. Right.

QUESTIONER: Right. So basically the administration went through six years without a serious energy conversation with the Chinese. And I'm trying to figure out -- considering you've got a 10-year plan and, as you say, this is long-range, and you want to turn something over to the next administration -- was there something about the nature of the Chinese-U.S. relationship during the course of most of the Bush administration that made this conversation impossible? And similarly, you'll remember that in the National Security Strategy rewrite that was, I think, 2005, right after the second term began, there was an explicit warning to the Chinese about the dangers of trying to lock up individual energy supplies around the world, and I'm wondering how they reacted to that.

PAULSON: Well, I would say I had -- on coming down here, I had talked with Bob Zoellick. I have a very high regard for him, and I know he was -- he had been a deputy at State. And he had been -- and I don't know the history, but he had been talking with the Chinese about energy. And so there had been, I think, various -- and I can't really refute what you say, because I just don't know the history, but I know at least in the year before I got here and, I think, probably going back longer, there had been a number of dialogues --

QUESTIONER: Yeah, there had been conversations --

PAULSON: -- discussions --

QUESTIONER: -- but there was no real initiative suggested --

PAULSON: But I think what --

QUESTIONER: -- unless I missed something.

PAULSON: -- I think what we did with the SED and -- was to say: How do we get this at a more senior level, and how do we prioritize, and then how do we not just have a meeting, but how do we -- you know, this is a continual process where we have these big formal dialogues twice a year, but then follow up -- and just really follow up on all kinds of things.

And so I -- when I was in China last week in the meeting with Zhang Ping at the NDRC and we were just going through, again, all of the different issues -- and I was dealing with -- you know, really down in the weeds, dealing with -- you know, they've got people that are dying because of sulfur dioxide, the SOx and NOx -- and so we've been working to help them. We have a cap-and-trade that's worked for sulfur dioxide in the U.S. and been very effective. So we're helping them design and implement a program.

Now, they have a more immediate need there than they do with climate, but they're very concerned about climate. And -- but if we work with them on the energy efficiency and on the SOx and NOx, we indirectly get to climate. But that's at the level we're drilling down.

But if you're saying does this initiative -- is this more prioritized, intense than it had been before, I think the answer is yes. And it's -- and I think we're making some progress.

QUESTIONER: I think what I was trying to get at, Mr. Secretary, is, who wasn't ready for this conversation in, say, 2002? Was it us, or was it them?

PAULSON: I can't -- I'm not even going to acknowledge it didn't take place. It -- then, because I think it probably was taking place. But I think what we -- what this has done is let us come with something that's much more effective to make progress, because just having the -- one of the things I had learned in dealing with the Chinese in the private sector -- it's not as simple as just going to the minister that's responsible. You know, it's not as simple as just going to the guy who runs SEPA, you know, the State Environmental Protection Agency or now the -- it is getting to a range of people and doing it in a way in which it's going to let us be more effective. And I think this is letting us do that.

I can't -- in terms of what was done before I got here, I do know that there were discussions. I know for a fact that Bob Zoellick pushed the energy thing very hard. And I tried to build on that and do it with a mechanism that we think is going to allow us to be effective.

QUESTIONER: One last thing. You didn't mention in your -- (inaudible) -- you didn't mention --

ROSE: David, we've got to let some other people talk.

QUESTIONER: Oh. Okay. I'm sorry. Go ahead.

QUESTIONER: I have a question getting back to the China currency. You mentioned the appreciation of 20, 21 percent against the dollar, which I assume is well on its way to Senator Schumer's original goal. But I wanted to ask what's -- how does the depreciated U.S. dollar affect the appreciation of the yuan? Or -- and -- or has it entirely been the Chinese policy changes?

PAULSON: Well, I -- what I've talked about is talked about the renminbi relative to the dollar. Okay. So the -- they have -- and if you look at it on a real basis after inflation, it's been at 25 percent. But obviously that -- given the movement of the dollar, the renminbi hasn't appreciated as dramatically against, as significantly against some other currencies, you know, like the euro and the yen. And so I think one of the things that we've tried to do and, I think, we've done with some success is encouraged other countries, to speak about this topic and to engage with the Chinese very directly on it.

You mentioned that in the next round of talks, one of the issues you're working on is the investment, the bilateral investment.

PAULSON: Right.

QUESTIONER: You also said like the investment, from China to U.S., is quite low at the moment and, you think, it's positive if it grows.

So I wonder, what kind of initiative would you take, during this round of talk, that can encourage more Chinese investment to the U.S.?

PAULSON: Well, a very good question, because we're always seeking to encourage investment, from every country into the U.S. And I think one of the things that's discouraged investment, from China into the U.S., is not understanding some of the processes over here, not wanting to be embarrassed if an investment is turned down, not wanting investments to be criticized.

You know, there are a lot of places they can go to make investments in the world. And I think the Chinese sometimes question whether their investment is welcome here.

And I think from their standpoint, talking through these issues and putting -- if we were successful in getting a BIT in place, which would give greater protections to investors, in both countries, I think, it would be an important milestone.

I'm not saying that it would lead to, you know, that in and of itself would lead to a great inflow of investment. But it would be a positive. And I think, you know, over time, increasingly you're going to see Chinese companies and sovereign wealth funds and others look to make more investment in the U.S.

And it would be, I think, a -- I take the view that the highest vote of confidence anyone can give, to our economy, is to make a long-term investment as opposed to just buying securities or buying U.S. Treasuries; is to make a direct investment in our economy. And so this is -- there's no short-term easy answer. But we, you know, a BIT would be, I think, a positive step.

QUESTIONER: Thank you, Paulson.

A follow-up question.

ROSE: Actually no. I'm sorry, we only have a little bit of time left. And I want to get as many people in as possible.

Going back a little bit to the Chinese currency issue and Congress, in July, a group of bipartisan senators let out a statement saying that, they thought, the administration's efforts were inadequate and in need of reform.

Is this something that has been addressed? Have you been in talks with the senators? You said, pulled back a little bit from the fact that Congress is satisfied. But you seem to think that things are moving in the right direction.

PAULSON: I think they're moving in the right direction. They -- I think that they, you know, that -- I think a good number of people think that the movement is inadequate.

(Audio break.)

I've talked with people around the world. And I think they've by and large been supportive of the kinds of actions we've taken and the policies we've taken. I just think it's important that they understand what's going on in the markets. I talk with Europeans; I talk with Asians; I talk with the people in Latin America. So we -- I think that's an important part of my job.

Thank you all very much.

ROSE: Thank you, Mr. Secretary.

PAULSON: Okay.

ROSE: Thank you, everybody. And we look forward to having you all back on our next call.

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